2023-04-03 05:44:18 ET
Summary
- A reader recently contacted me regarding his investment in Prosus, a company I've been covering for some time. I decided to do a small update here.
- My thesis in January was cautious. The company has underperformed index by more than 5% since that time, making it more than just "bad luck".
- Prosus remains a tricky investment going into a higher interest rate environment.
- I argue the company lacks relevant experience to handle this sort of context, and may very well fail. It's a high-risk investment, and I want to reiterate this.
Dear readers/followers.
My very first article on Prosus ( OTCPK:PROSY ) was a cautious one - and the return since this stance has been negative, validating this thesis. The thesis as It continues is still validated, because I continue to be cautious on Prosus. The company is, as I see it, a Tencent ( OTCPK:TCEHY ) proxy with a portfolio of risky "potentials". it has more similarities with your typical VC firm than a "real" investment in a sound and stable company.
At least, this is my view - I know many disagree with it, including the person who contacted me and asked me for an unbiased/objective update.
I am happy to provide this.
I also believe that I've proven my "mettle" when it comes to Prosus. I haven't always been negative, as I believe there to be a time for when this company can be a speculative buy. If you had followed my native targets of €40-€45 and not deviated from it, you could have made significant amounts of returns. I did not - I invested in other things, but the reader who contacted me did.
So, this is an update for everyone interested in, or having Prosus on their watchlist.
Prosus - An update for 2Q23 and forward
I like investing in investment companies, at least in theory - and Prosus is an investment company. However, investment companies come with different qualities and different aims. Some companies own large stakes in fortress-type companies, managing and owning and paying out a conservative dividend, many of its holdings not even public. This would be your Investor AB ( OTCPK:IVSXF ). I own 4% of my portfolio in Investor - it's my largest investment company stake, and I am up over 40%.
Then there are the investment companies that try to play the "short" game. Those are the companies that want to buy a business or a stake in one, develop or flip it, and sell it for a designated IRR. This would be similar to Kinnevik ( OTCPK:KNVKF ). Or, as in this case, Prosus.
I do not own Kinnevik, and I do not own Prosus. It's a matter of business models. I like Investors Business model. It's what allowed the Wallenberg Family to essentially come to dominate Swedish Industry, while the family behind Kinnevik has seen failure after failure. It's understandable - their strategy is far riskier and short-term.
I've called Prosus essentially an angel investor firm or a VC, but this is not strictly true, because Angels and VC's tend to go in earlier - Prosus "buys in" once the companies in question have shown a bit of promise.
The business idea is essentially to hold a portfolio of a lot of small companies, and hope that one of those companies really "pop". That's pretty much exactly what happened with Tencent. It is also what didn't happen with about 20-50 other companies that Prosus has been investing in for years, and sometimes over 10 years.
It's really quite simple - what I look at is if Tencent's "popping" had anything to do with what Prosus enabled the company to do, or if it had more to do with the circumstances of that particular time - such as the timing in China in terms of macro, and the world overall. And when looking historically at Prosus and Tencent, I see Tencent's success having more to do with the general macro and circumstances where the company was created than it had with Prosus management of the stake.
In simple terms, Prosus could not repeat the feat if it tried to do so today.
At least, that is what I believe.
However, Prosus has "made its nut". The Tencent stake now acts as a capital safety for any investment that the company has made, and seeks to make. Since I last wrote about Prosus, a few things have happened.
First off, the NAV/share is now down to €93/share. Secondly, we're going into a rising interest rate environment, which influences the interest for these sorts of higher-risk investments. Prosus doesn't have debt - it has $600M worth of net cash, and with its Tencent stake, it can continue to liquidate billions as needed.
The company continues to point to the revenue growth of its businesses and various segments - that and other top-line KPIs which the company views as relevant.
And it is not that I am saying that these KPIs are irrelevant or even "bad". The company's brands in all of its segments are technically attractive - at least if you take a look at them online. The problem is the same as we saw during the dot-com bubble over 20 years ago when I wasn't even investing in the stock market - because I was in junior high school. None of them really have proven profitability or long-term relevance.
It is hard for me to put into words just how much I demand/require for a company to really "prove" the viability of its business model. The best I can say is that I won't invest in a company without it. Revenue growth is not profit growth, and revenue is not profit. The company also points to its buyback program, to which I can only say that I consider the buyback program to be irrelevant, even if it results in increased Tencent exposure.
That's not to say that every one of the company's segments or sub-segments is inherently unprofitable. The core classifieds business is profitable, if barely (but goes negative once Auto is included). The same is true for the core restaurant business - again, goes negative once new initiatives are included.
Edtech continues to operate at a significant trading loss.
And the company is doing things that I expected it to do a year ago when I started forecasting rising interest rates and a downturn in interest for these sorts of investments. It's exiting its wholly underperforming businesses, focusing more on costs, and trying to grow organically and optimizing current operations rather than trying to expand into more. It's trying to stem the outflow of money, and this is a good thing.
However, with so much of the company's profits coming from Tencent, any reduction here is absolutely lethal - and we've seen what this can look like for 1H23. Take a look.
Prosus remains at BBB, a 12% LTV based on gross debt, and interest coverage of 2.1x, and remains at a relatively low cost of debt of 3.2%. Any fundamental issues for Prosus based on the size of its Tencent stake are still far, far off. The fact that the company has pretty much "shuttered" the doors on new investments (the company says it's highly disciplined, but hasn't made any significant new pushes in some time), means that this will slow down even further.
But it also calls into question, as I see it, what sort of upside or growth potential we're actually investing in here.
Prosus valuation - Remains a difficult prospect
Some new facts to consider and perspectives to look at here when taking valuation into consideration. Let's look at comps first.
Prosus trades with peers in the interactive/media investments segment. In this peer group, Prosus has one of the worst Gross Margins in the entire industry and a sub-par/lackluster operating margin. I wouldn't necessarily put too much relevance in these specific comps and some of the numbers here though, because its' being compared to Baidu, Google ( GOOG ), Tencent, and other pure "growth" plays. Even I can see that Prosus is a bit different than that.
However, warning signs are clear, for anyone who knows what to look at. None of these high-level signs are definitive, they're just worrying. The company operates at a loss (operating income), it keeps issuing debt (not that worrying given Tencent), it's in a GM declining trend, its P/S and price is close to 1-year highs. What's more, a simple 8-factor Beneish model shows that the company is at a high risk of manipulating its profit figures. It looks at indexes like GM, Asset Quality, Sales growth, D&A, Leverage, SG&A, and Accruals.
Just like with something like the Altman model, I wouldn't say a bad score here means that the company is doing something nefarious - I'm saying that a bad Altman or a bad Beneish score is never a good sign. We know the situation that Prosus is in. It's looking for its "next big thing", after one of the largest successes in corporate history, its work with the Tencent investment.
And for those putting Beneish into question as a rule, remember that a group of business students at Cornell were able to predict that Enron was manipulating its earnings - It's a good model - you just have to know how to apply it, and what relevance to put to it.
As it stands, I am anything but convinced that success is something we will actually have. The company is forecasted to continue to operate at a loss - over half a billion in negative EBIT for 2024 and half a billion in negative EBITDA for 2023. The company currently operates at a negative ROIC/WACC of -7%. This also doesn't necessarily matter, because I know how to value investment companies, and how I want to value them.
I continue to value Prosus as a Tencent proxy and a good way of investing in Tencent.
Because by buying Prosus at the right time, you're sometimes able to pick Tencent up at an impressive discount.
1:1 NAV is a guidance mark - and where I would be accepting things if the company had a solid set of dividend-paying companies added to by some nice investments that are not public, but also pay a nice dividend.
That is not the case here with Prosus - Prosus, as I see it, cannot justify a 1:1 NAV/share price target.
I know exactly what sort of investment companies I'm looking at and investing in, and what to expect from them. All of them have 90%+ listed portfolios of quality companies often going back 100+ years. They pay a yield. They're not flighty or sudden with their allocation or investments. They have very specific strategies for holdings and holding times (usually forever) that I agree with.
I'm still wanting to discount the company 70% before buying, which means that I won't pay more than €35/share for Prosus.
I hope this shows you how long-term I consider my investments and my price targets - they are not chosen lightly, on a whim, or just because other analysts give them.
With that, I give Prosus the following thesis as we move into 2Q.
Thesis
My thesis on Prosus is as follows:
- Prosus stock remains a somewhat unattractive investment due to the specifics of how the company operates and what it has. This lack of appeal has increased, as I see it, as we've moved into a higher interest rate environment where the demand upon the company's investments in terms of profitability - which rely on cheap capital and being able to operate at a loss for some time - has increased.
- The shareholder structure is unappealing and inherently disadvantageous to Prosus investors. While the company is fundamentally sound and has a good track record due to the Tencent investment, there are too many fundamental question marks to really make this an option for me.
- I would be interested in Prosus if the market decided to discount it more than 70% to its current NAV.
- I consider it a "HOLD" here. My PT is €35/share.
Remember, I'm all about
1. Buying undervalued companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime. Even if that undervaluation is slight and not mind-numbingly massive.
2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
3. If the company doesn't go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.
Here are my criteria and how the company fulfills them ( italicized ).
- This company is overall qualitative.
- This company is fundamentally safe/conservative & well-run.
- This company pays a well-covered dividend.
- This company is currently cheap.
- This company has a realistic upside based on earnings growth or multiple expansion/reversion.
Too few of my criteria are fulfilled by the company. I can't call this anything except a "HOLD".
For further details see:
Prosus: Underperformance Confirms Q1 2023 'Hold', Looking Forward